Warren Buffett. He is one of the wealthiest and the most influential people in the world. I am not an expert in investing stocks. However, I want to share what I learn about 4 rules that Warren Buffett uses for investing in stocks today. Since a key to his approach is important to what I do. He considers to purchase shares of a company when all 4 rules met.
- Stock must be stable and understandable
- Stock must have long term prospects
- Stock must be managed by vigilant leaders
- Stock must be undervalued
Fundamental of his stock basics is “the stock market is nothing more than a place to buy and sell his shares of the business”. The market only provides a platform for him to purchase undervalued companies. According to what he said, the stock market could close tomorrow. (I still believe importance of platform in any industry, but he is absolutely right that the platform can die anytime.) He never tries to make huge returns right away, but look for consistent gains at reasonable levels. Well, purchasing something in undervalued price and see the market as just a place to buy and sell… everyone can think that way, but how he applies that idea into business is amazing. Personally, how he determines the value of the company is more amazing. He basically uses two ratios and multiplies those.
- Market Price / Earnings (P/E)
- Market Price / Book Value (P/BV)
For example, if market price is $20 and earnings are $2, P/E ratio is 10 which means you may have 10% return at the moment. By the way, book value is the value of an asset according to its balance sheet account balance. Lower P/E represents higher potential returns, and same formula to P/BV. He close looked at multiple of P/E and P/BV lower than 22.5. P/E ratio lower than 15 and P/BV ratio lower than 1.5 would be the number that he looks.
One of the key messages that I got from his teaching was he makes decisions based on analyzed numbers. Investments can be subjective. I would invest in company A because I “think” the company has a good future. The statements said to me that I am investing the company because I like it alone. To be more objective, facts and evidence will bring us more rationals to make decision. Investment requires sources to risk, to reduce the risk on sources, pursue facts and evidence. Another important lesson of power of analytics. GOD Bless.